BLACK SCHOLES MODEL

INTRODUCTION

Developed in 1973

Myron Scholes & Fischer Black

Robert Merton
also participated

Professors at MIT and

University of Chicago

Model
Price

follows amotion with constant drift and

volatility

The

formula takes into consideration the price

of;
Underlyingstock
Strike

priceof the option

Amount

Computers

the use

of time before the option expires

have greatly eased and extended

Formula

Divide the formula into two parts

The first part is SN(d1), derives the

expected benefit from acquiring a stock
outright

This is found by multiplying stock price [S]

by the change in the call premium with
respect to a change in the underlying
stock price [N(d1)]

The second part of the model,

Ke(-rt)N(d2), gives the present value of
paying the exercise price on the expiration
day

The fair market value of the call option is

then calculated by taking the difference
between these two parts.

Assumptions

The stock pays no dividends during the

option's life

European exercise terms are used

Markets are efficient

No commissions are charged

Interest rates remain constant and known

Returns are lognormally distributed